How do I value my business?

I would like to know the value of my business without paying accountants / valution fees at this stage. Does anybody know of an approximate ‘rule of thumb’ guide I could use. We are an employment agency with a turnover of £300k; projected turnover for our next financial year is £700k. I am keen to establish the value of the business because I am considering giving a member of staff some equity in the business, but would like to know the cost of how much I am actually giving away.

We designed our model VALUER to enable business owners to easily calculate a realistic valuation without the need for outside help. Purchased by businesses worldwide and all sizes it is ideal for your business as the future growth rate (what you would be giving away once sold) is taken into consideration. Check out the responses from users! http://www.business-valuation-software.co.uk Regards John

Alfie, Valuing a company is inherently a tough task, in that there will never be a “right” answer unless you have been made an offer for your company. Ultimately that is the companies value – the best price someone else is willing to pay for it. Someone else’s value of your company tends to be what they are planning to do with it, not what you are doing with it currently, so this is a very subjective thing. As a rule of thumb with professional companies, it is normally a turnover multiple depending on the quality of the margins. Ie in accountancy circles the going rate is around 1.1 to 1.25 times the "gross recurring fee", where a block of fees are sold. I don’t know off hand what the going rate is in your field, I would suggest you have a little look around in trade magazines, I’m sure you will find a specialist broker offering to buy/sell other agency practices, and from that you can get a yardstick valuation multiple and apply it to your own turnover and growth rate. This isn’t an exact science. The valuation software being touted above (and I hope this post wont be repeatedly bumped to the irritation of other users like the other one, which is still being bumped nearly a month on) is ok up to a point, it works on valuing the future cash flow of the business, and “discounting” it to current values by way of an interest multiple, but IMO such software tends to lull the user into thinking just because the underlying model is complex, the answer is better. In my experience it tends not to be, and the answer you came up with on the back of the preverbal *** packet is as good as the complex academic solution, and the “quick” solution tends to leave you more open to thinking about the wider issues of growth, competition and profitability, which is really at the heart of a good valuation. Hope this is of use. Regards, James Smith Chartered Accountant http://www.uktaxshop.co.uk 01284 764436

I would suggest you consider a profit share scheme before equity for an employee and see how that works first. Easier from a legal perspective to control than equity and you can always consider equity later if the profit share is successful.

Hello Again Alfie I wish to respond to the post from James Smith as its content is precisely why I embarked on a quest to find a fairer and more appropriate valuation method for non-stock market listed firms. Like most business advisers not studied in the science of valuation, he uses the ‘ its only worth what someone will pay’ line. Your initial post requested help in valuing your business not asking what someone else may offer you for it! Smiths rule of thumb turnover multiple has no scientific merit whatsoever and it has caused many businesses to fail post purchase as the new owners discovered that the net income generated was insufficient to cover the cost of purchase! *** packet methodology is most definitely NOT as good as an academic evaluation of the subject business! No two businesses are the same which makes ‘yardstick valuation multiples’ rubbish! He also fails to understand my adaptation to the classical discounted cash flow (DCF) method. I do NOT discount the cash flows by an interest multiple. This is the historic way and is wrong (see the web site for more information on this). MY factor is calculated on the holistic evaluation of the business in relation to its market position, industry cycle stage and general economic conditions. I have explained this in detail in the web site. Download the free demo and you will discover that I have explained in detail the process and not, as Smith states, trying to make it sound complex. Be wary of accountants preaching about Jurassic ‘profit based’ valuation techniques. My software is receiving more and more interest from business groups and this web site is currently discussing with us the possibility of offering its client base access to purchase it through them. I doubt that Mr Smith will be placing an order! Best regards John http://www.business-valuation-software.co.uk

Kermey, could you please explain why you think that accountants are the experts in valuation? Because THEY dont! And also explain why they are better than ‘a piece of software’ that took two years of research and is purchased BY accountants every day? I sell my software to them at http://www.accountingweb.co.uk (the worlds largest accountancy web site!) Can’t wait for your reply [:D] P.S. If you are interested in a good web site design go to http://www.com.munique.co.uk They are very good! http://www.business-valuation-software.co.uk

I don’t want to get into an impassioned debate (although John is good value when he isn’t bumping his threads) but in the specific instance of a professional company an earnings multiple is a perfectly valid way of quickly valuing it. If for no other reason than this is the way such companies are valued in the market place. I know my house is worth about £250,000. I know this because one of the ones down the road of a similar design sold for this last week. I don’t know the details of whether mine is more marketable, or whether they have a better kitchen, but I know that ballpark its worth about £250k, because that is roughly the market price. I could spend several hours analysing the ins and out of if mine would raise more or less than this, but until someone makes an offer its all rather academic, so I wont bother. What it worth to me is probably a little more. I have no intention of moving, but if someone offered me say £300k I would probably sell. But why would it be worth £300k to someone else? Well maybe the person buying knows there is (unknown to me) £100k of gold bullion stashed under the floorboards, or happens to know the planning committee on the council will grant him the right to bulldoze it and build 10 flats on the site making a small fortune. This is why business valuation is so hard – and why technical analysis tends to fail. You have to get inside the purchasers mind to get to a value, and its all about expectations and what you are going to do with the company. I tend to find the starting point to be a market based valuation, backed up with specific analysis as required depending on why the transaction is occurring as the best option. I personally find starting with a blank piece of paper is the best way to go as you are not constrained by any one model, or tempted to over sophisticate what is only ever going to be the start point of a haggling process to achieve a price. In the two large (read multi-million) real world company purchases I was involved in when in industry, the numbers we put together went out of the window when bidding war commenced – one was purchased for about 25% higher than the agreed maximum for “strategic reasons”. The running joke was the strategy was for the CEO to have it on his CV that he had acquired XYZ ltd. (Actually that would actually make an interesting study for academic types – how many purchases exceeded the valuation figures proved by bean counters ?) In the occasional small SME valuations I get involved in now, the same passion tends to colour any rational fiscal argument, which is why I come back to “ballpark” numbers being fine in business valuations as it all comes down to negotiation. I tend to concentrate on finding things in the accounts that can be used to negotiate down the price, rather than trying to value the company as a whole, as this tend to bring my clients the greatest benefit. That said im sure there would be some accountants who like a technical solution, and would back John’s model. We certainly don’t all sing the same tune. I would also like to add I have not spend any great time looking at John’s model in detail, and as I said originally it can be an ok way to go. Btw I would suggest Lee Schawtz has made the most sensible suggestion in the thread! James Smith Chartered Accountant http://www.uktaxshop.co.uk 01284 764436

Dear Alfie First and foremost, as Lee says, and James reiterates, use an approved incentive scheme to make sure the employee receives a tax efficient incentive rather than just a tax bill. There is a rough guide to share option schemes for ventures on our site should you be interested in taking a look: [url]http://www.innovateur.co.uk/options.html[/url] – and we are not trying to sell you anything! I am going to have to offer my opinion on the rest of the thread, as even though I am in Mexico at the moment, I feel the need to comment – particularly in light of the methods and style used by Welford. Welford´s Model Makes a Number of Assumptions and is an Opinion The fact is that Welford´s model is based on a set of assumptions. All users should know that this model carries NO AUTHORITY WHATEVER in the world or real markets or when dealing with auditors (i.e. when actually selling or when actually achieving an authoritative valuation). It is a guide that is all, based on the assumptions they have made about what a value of a business should be and is not substantiated by independent empirical study, or reality. By all means purchase it if you want, and it may be a useful tool, but remember that it is just someone’s opinion of value. I have been involved in the valuation of many projects and ventures in the real world (i.e. when looking at investment, purchase or sale), and the reality of valuation is that at a fundamental level the valuation of the business is set by the market – not by the opinion of third parties or a hybrid model that may throw in more errors than proven methods. To dismiss a valuation based on what someone is prepared to pay should ring alarm bells in anyone considering Welford´s model. It shows a fundamental misunderstanding of reality. If I have an ounce of gold, the only real indicator of value is what someone else will pay me for it. For Welford to effectively suggest that what someone will pay for a business is fundametaly flawed is utter nonsense. It is perhaps no wonder that there are just 8 registered users (including in-house staff) on his Valuation Forum even though it has been open since August, and it may be that some could suggest that may be the reason why he seems to spend a disproportionate amount of his time spamming users on this forum and using what many regard as highly questionable methods for trying to raise the subject of valuation! Welford´s website also has some fundamental errors in describing SOME of the different methods of valuation that should be pointed out. It for example: 1. it implies that a Book Value valuation does not assume the business is a going concern, when it actually does. It does not incorporate future income, but it most certainly values the assets as a going concern – for they would fetch lower valuations in a firesale than their book value. 2. It regards stock market valuations as less accurate than those which an individual investor with industry knowledge would place on them, when the fact is empirical analysis has show countless times that the most advanced for of valuation we have is that provided by the stock markets. Not understanding this shows a further lack of knowledge of the underlying research. 3. It states that the profit sales multiples methods are weak for SMEs because they make assumptions about the future. ALL the methods discussed, except for Book Value, make assumptions about the future – including his model! …etc. Perhaps you could clarify these Welford as I am sure the lack of clarity was just due to getting the site up quickly and attempting to offer a simple explanation. It is also always better to take advice from those that have been through the process of buying, selling and investing in businesses rather than those who have not. Before Welford spouts off again in one of his simplistic and insulting rants, I probably ought to add that in addition to real experience, I have a number of postgraduate qualifications in business and finance, have taught business at university, and have headed up national and international operations in diverse businesses. I started in SMEs and now support them passionately and also work with further complex valuation variables involved in high growth potential. It is in that context that I provide my opinion. For a more thorough valuation, you would usually rely on a combination of methods and that will give you a more holistic guideline. The reality is that SME business valuation is complex and the only real value, if you are looking to sell, is the value someone will actually pay you it. If you are not looking to sell, then a method based on discounted cashflows is the most thorough process (and you can do it yourself, it requires only the knowledge of the data you have to put into Welford´s model and the basic formula which you can insert in a spreadsheet – it need not cost you ´thousands’). Howe

quote:Originally posted by welford01 Kermey, could you please explain why you think that accountants are the experts in valuation? Because THEY dont! And also explain why they are better than ‘a piece of software’ that took two years of research and is purchased BY accountants every day? I sell my software to them at http://www.accountingweb.co.uk (the worlds largest accountancy web site!) Can’t wait for your reply [:D]

Because James talks sense while you are just trying to push your dodgy product.

quote:Originally posted by welford01 P.S. If you are interested in a good web site design go to http://www.com.munique.co.uk They are very good!

Yes its a shame that an opinion is gathered over behaviour on this site as well as advice. James is the consummate professional and you just know you can trust him- based on his excellent measured advice, whereas marketing a product agressively just puts you off even a really good product………

Can I just say thanks to Innovator for taking the time to look at that product in detail and providing that detailed anaylsis. A real credit to the forum. As I said above I didnt review the product, and it appears to be some what worse than I had anticipated from looking at other similar products I have seen in the past. James Smith Chartered Accountant http://www.uktaxshop.co.uk 01284 764436

Hey! Hey! Whats all this? Suddenly the forum has changed to ‘lets bash Welford’! Somebody’s been busy this weekend! OK, here we go! Mr Smith , (I must admit, I am starting to like you!) valuing a business on a comparatable is Estate Agent mentality! Here is an example why it doesn’t work. Two fish and chip shops operate in the same town. One owner gets up early to get the best fish and uses the best oils. Owner two plays golf in the morning and the oil stays in longer than advised. Forget what the customers might do because when you are looking for a comparison you will generalise. Is that a fair method? Innovator (or whatever your name is)! EVERY THEORY, CONCEPT AND IDEOLIGY IS BASED ON ASSUMPTION AND/OR BELIEF! (You sure you went to Uni.?). Also, no valuation technique has authority (OK, apart from traded stock market – see below!). It just has users. And a high number of users give it credibility. My model is creating credibility through its continuing interest. It may not have empirical study but the reality is that it has achieved for buyer and selling a happy outcome to their negotiations. Job done! VALUER is not my opinion of value. It is designed to give clarity to the process and is based on what the business will achieve in the future. Not just the past! The user inputs the raw data required to calculate the firms worth, not me. VALUER represents THE USERS opinion of value and assists them in justifying this figure. PE ratio won’t! Don’t fall into the ‘what someone will pay’ trap. It sounds like you are saying that the buyer has divine knowledge! Every buyer needs some process to determine what the ‘prepared to pay’ figure is. I have argued that it may be whatever risk funds they have available, it may be their belief that they could squeeze more income from the business than the present management, etc. But you can bet your last dollar that they will use a model to determine the price they are prepared to pay! Book value assumes that the net asset position is achievable either by producing return via a sale of these assets or by their utility. The UK stock market itself states that ‘the share price quoted may have no reflection on the firms ability to product profit both now and into the future’. It is based on hearsay, analysis, individual or collective belief and a host of other reasons. It works because it is accepted by all! I am saying that no two firms are the same so it will never be possible to find a comparison. I am also saying that beta (as a measure of risk) relies on an industry proxy and therefore is unfair. IT THAT CLEAR ENOUGH FOR YOU? ‘Getting the site up quickly’? What’s that about? Are you saying ‘the longer it takes to get the site up the better it is? Now THAT is based on assumption! And you are telling people to rely on a combination of valuation methods! What is your equation? Add up all the valuation amounts and divide by the number of methods used? As about as much use as you advising Alfie to multiple turnover by a factor! And which turnover would this be? Last years £300,000 or next years ESTIMATED £700,000! There is going to be a hell of a difference! Alfie, I am one of those who make management and business more enjoyable. A maverick that has shown repeatively that adherence to Stone Age methods or boring ‘dead men’s glory’ achieves nothing more that medioca working environments and results. What innovator is most peeved off about is that fact that I have the cheek to stand up and argue against his/her perceived wisdom. It can’t be my software because he or she does not understand it. If he/she did, he/she would not have stated that you could duplicate it on a spreadsheet! I now publicly challenge him/her to do so! If you are rich and powerful you can sometimes influence the price of a stock market listed company in your favour. Innovator regards that method as the most advanced. Would you? Kermey. Ouch! But I was hoping for something more than ‘ because somebody else said so’! What a great game of rugby today!

I think the point is now made. Business Valuation by a Maverick? If you want to describe your method as a “Maverick´s” valuation then that is fine. Your choice of words, but it finally makes the point. Model more Objective than the Market? The most worrying thing for me is that you have a fundamental misunderstanding of a market. What a market is prepared to pay is REALITY – that does not mean what one individual is prepared to pay – that is not a market! (unless you only have one potential customer, or have only marketed the business to one!). Does a Model Influence Value More than Marketing? In the real world, how effectively you target and market the business will have a FAR higher influence on the price achieved than sitting around and looking at an opinion of value that is not even supported by empirical study! Other practical measures like succession planning in family businesses, or planning an effective exit route, will make a real difference too. Investment Decisions by Real Management Teams! As for how a management team trying to buy a company because they think they can extract more value from the assets than the current management. That team will produce a plan about what they think they can do with the business, they will assess what the minimum return they expect to receive on their investment, the level of risk, and the return that they want as management, and then ideally, through a robust investment appraisal method (usually a series of methods), set the maximum price they would be willing to pay (there may also be strategic reasons for the investment that they will consider). They can then get into the real world of the market and actual negotiation where real market forces will actually come into play and the price realised will be SET BY THE MARKET – and James has described some of the dynamics involved then. Innovation is About Delivering Greater Value! Just doing something differently is not Innovation. Innovation is about delivering greater value. “Alfie´s” Situation – 300K or 700K? “Alfie” should base his valuation on the current realities of their business. To motivate an individual of the team he should look at current performance as the base value (the performance now!). If there are further contracts in place for the future that are already highly probable then those too should be added. That is the base level of his current business and he can then incentivise the individual by allowing them to share in any growth that they are involved in creating beyond that, they may also want to incentivise the individual to ensure they actually help to maintain the current value of the business as just because it has grown in the past does not meant it is certain to grow in the future. That is a reasonable and practical basis for his purposes. Positive Stock Market Manipulation by the “Rich and Powerful”? You should also not try to persuade people that the price of their company on the stock market can be positively manipulated in their favour by the “rich and powerful”. You try telling that to those directors in the Guinness / Distillers case who ended up in jail for trying to artificially manipulate the market (and I have met and discussed this with one of them to get their perspective). The only way to legally influence the stock is through marketing activities, and supply / demand issues. If one large player puts their money where their mouth is and starts buying a material amount of stock, they will be required to report their activities above a certain level and the rest of the market will make its mind up as to why. That is the REALITY of supply, demand, and information in the market. There will be short and long term views in play, the market will process information about macro and microeconomic outlooks in a far more sophisticated way than ANY MODEL WE KNOW OF. The simple FACT is that empirical study has repeatedly shown that stock markets are the most efficient system we know of for valuing stocks. A stock market is a far more efficient way of processing all the available information on a stock than a simple two dimensional model – and that has been proven again, and again – something you should know if you are familiar with the advanced empirical studies of stock markets. To attempt to persuade this audience that your method produces a “better” valuation than the most efficient market we know is worrying at best. Guidance on Improvement – How to Make your Model more Useful! You know I am cross with you, and in addition to advising you to review your marketing methods so as not raise concerns you have given rise to here, let me give you some more constructive feedback on how you could improve the value added by your model and overcome some of its inherent weaknesses. It would not

What a shame Inno, that you regard mavericks as a negative thing! Without us what a boring uncreative dispassionate world we would live in! Still, each to his own. Its not what a ‘market’ is willing to pay that is important. It is the effect on the seller and buyer of what they have received as either compensation or what they got for their money. I don’t value a company on a market perspective! I value it as a separate entity (I give it an identity of its own). It’s not about marketing. Businesses should not be transferred on the basis of whose spill is the sexiest! We need a more rational approach for SME’s. You can plan a price to death using a multitude of ‘what we think’ scenarios. The reality is you can’t fault a ‘what cash is this business going to generate with its current make-up’ formula – and that’s what I am paying! I can’t fault your advise to Alfie. Good for motivation. You met a Guinness director? What were you in for? But you agree there is a legal way of influencing the stock market. So, the ‘they’ are more sophisticated then we mere mortals? Spooky! The stock market is efficient due to real time information on stock movement and pure guesswork. By the way, I did not design my model to value a stock-market company. But they buy it. Well you said it. You are brighter than me. But I won’t give a comparison model which will give a different value. That doesn’t gel with a maverick. We stick our necks out and open ourselves to criticism. That’s forces us to justify our product, not hide with the pack. Good luck to you too.